Higher interest rates could slow loan growth and raise banks’ funding costs, which could reduce the capital that companies need to grow The Fed’s current rate-hiking cycle may not usher in a prosperous period for bank stocks as interest rates rise and the yield curve flattens, which could be a problem for the broader stock market. While the 10- and 30-year rates have gotten all the attention, the real show is happening at the front of the yield curve — the spread between longer-term and shorter-term yields — with the 2-year yield climbing even more than the 10-year . It is easy to see; just look at the spreads between the 10-year and the 2-year.
The spread has narrowed to just 21 basis points (0.21 percentage points), compared with more than 70 basis points before the U.S.-Iran war started. Infrastructure investing: A hedge against inflation and geopolitics?Play video: Infrastructure investing: A hedge against inflation and geopolitics? This could significantly affect financial stocks, as higher rates could slow loan growth and raise banks’ funding costs, while a flatter yield curve could pressure net interest income, all of which could negatively impact bank earnings.
Net interest income is the spread between what a bank receives in interest payments on loans and what it pays out in interest on deposits. Don’t Short Yourself offers weekly money tips to help you earn it, stack it and grow it. I would like to receive updates and special offers from Dow Jones and affiliates.
I can unsubscribe at any time. And that matters for not only for the broader stock market, but also for the economy. If banks pull back on providing loans because they become unprofitable, companies will have less capital available to them to grow their businesses and consumers will have a more difficult time borrowing money to spend.
While investors cheer the S&P 500’s recent gains and moves toward record highs, the Financial Select Sector SPDR Fund is almost 6% off its highs. The sector’s decline began on Sept. 4, the day the market received the strong August jobs report. From there, the bond market started to take the Fed seriously as it neared a rate hike.
It is no surprise that banks have struggled, as the XLF ETF has traded closely with changes in the yield curve over the past three years, and even longer, depending on how far you want to look. The 5-year Treasury rate minus the 2-year Treasury rate shows that the XLF ETF has moved right along with changes in the yield curve over time. Financials could face a considerably challenging period if the Fed hikes more in the coming months, which seems likely given the hawkish outlook the Fed laid out through its “dot plot” and press conference, and the current path of inflation.
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